Puerto Rico judge seeks legal support to approve COFINA revisions

Bonds

Puerto Rico Title III bankruptcy Judge Laura Taylor Swain raised further last minute hurdles for the final approval of a restructuring plan for $17.6 billion of sales and use tax bonds.

In addition to ordering a supplemental brief in support of her legal authority to approve the Oversight Board’s revisions to the Puerto Rico Sales Tax Financing Corp. (COFINA) plan, Swain on Tuesday also permitted the Puerto Rico opposition Popular Democratic Party to file an amicus curiae on its opposition to the plan.

On Wednesday the PDP’s caucus in the Puerto Rico Senate filed the amicus saying that the board-proposed COFINA findings of fact would amount to “legislative entrenchment.” That is, the findings of fact would illegally bind successive legislatures to the November-passed “New Bond Legislation” that is a necessary part of the COFINA deal. The caucus noted that none of its members voted for this legislation, which Gov. Ricardo Rosselló subsequently signed.

Puerto Rico Senate Minority Leader Eduardo Bhatia Gautier said that future legislatures can’t be bound to observe the proposed COFINA agreement.

At issue is the court’s approval of a restructuring plan agreed to by holders of the biggest class of defaulted Puerto Rico debt. The Puerto Rico Oversight Board said last year that with the proposed deal, if bond trustee money was included as the plan specifies, there would be recoveries of 93% for COFINA senior bondholders and 56.4% for COFINA subordinate bondholders.

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Swain ordered the proponents of the adjustment plan to file a supplemental brief by 6 p.m. Atlantic Standard Time on Thursday to address three topics. First, the brief should address “the legal basis for the proposed findings regarding the valid establishment of Reorganized COFINA and Reorganized COFINA’s status as a separate independent corporation and instrumentality.” Second, it should provide “factual support for the proposed finding that the documents contained in the plan supplement constitute valid legal documents and contain valid provisions that are enforceable in accordance with their terms.”

Third and finally, Swain said it should give “the legal and factual bases for the proponents’ assertions that the court has authority to determine and declare the substantive validity of the New Bond Legislation and to resolve, based on the proposed settlement of the Commonwealth-COFINA dispute, the constitutional and other legal challenges to the COFINA structure raised under the Constitution of the Commonwealth of Puerto Rico in the manner set forth in the proposed findings and conclusions.”

On Wednesday morning Puerto Rico attorney John Mudd tweeted, “Very telling that Judge Swain granted the request for an amicus brief to the PDP who is claiming that she cannot change the PR Constitution nor allow SUT tax ownership to be surrendered.”

Later on Wednesday, Mudd tweeted, “It will be very interesting to see what the board says now with the PDP brief on the order of COFINA. The judge may not accept the language and force its elimination if they want to approve the agreement.”

Municipal bankruptcy expert James Spiotto said he thought the latest filings were less significant. Of Swain’s order for a memorandum, he said “I think she wants to be certain that she has a sound basis for what she’s doing.”

In their brief, the PDP Senators led by caucus leader Eduardo Bhatia Gautier argued that the Puerto Rico Constitution only allows “legislative entrenchment” on the tax and spending power of the legislative assembly for general obligation bonds. Other sorts of debt “must be treated like any other contract.”

The senators said the remedy for breach of contract is “simply damages.” They also mentioned the legislature’s right to breach contracts for “police powers.”

They said the New Bond Legislation prohibits successive legislatures from reducing the pledged COFINA tax below a certain level or determining how the COFINA pledge tax revenues should be used.
The senators ask Swain to add wording to the proposed COFINA order and finding of fact that states they are “subject to amendment or repeal by the Puerto Rico Legislative Assembly and (b) subject to legal challenge as unconstitutional, by any person (including, without limitation, the Commonwealth) other than COFINA and its creditors.”

Spiotto said that the senators’ objection had extremely limited validity. It is true that one legislature cannot normally bind another. However, Spiotto said that if a legislature approves a contract, it normally binds successive legislatures. There are clauses in both the Puerto Rico and United States constitutions that bar impairment of these contracts.

Under extreme conditions a legislature may have “police powers” to break a contract for public purposes, Spiotto said. This is a very high standard and doesn’t seem relevant to the situation.

On Tuesday in his Control Board Watch blog and before he was aware of Swain’s new request for a memorandum, Mudd wrote, “Will Judge Swain refuse to sign the agreement because she cannot change Puerto Rico’s constitution or will just shrug and do it? If she does not sign it, what will the board and COFINA Ad Hoc [Senior Bondholders] do? Judge Swain cannot change the plan of adjustment but she does not have to approve it either. The alternative is dismissal via [Title] 11 United States Code section 930.”

“The order is requiring additional information in support of the plan of adjustment,” a board spokeswoman said. “Our attorneys plan to comply with the order.”

The Ad Hoc Group of COFINA Senior Bondholders declined to comment.

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